Journal of Applied Finance & Banking, vol.2, no.4, 2012, 13-24
ISSN: 1792-6580 (print version), 1792-6599 (online)
Scienpress Ltd, 2012
Do dividend policies signal Corporate Operating
Characteristics?
Reza Raei1, Mohammad Moradi2 and Hoda Eskandar3
Abstract
Dividend policy is one of controversial financial issues. There are various theories
about dividend but in this study, the focus is on empirical test of signaling theory.
This theory says that the payment of dividends provides information for investors
and analysts. The aim of this study is preparing the evidence on dividend signaling
about corporate operating characteristics (return, performance and earning).
Therefore, linear regression models were fitted. Results showed that significantly
positive correlation exists between dividend and return. Also, there was a similar
relationship between dividend and earning. It means that dividend has information
content about return and earning and so, signaling theory was approved about
them. Nonetheless, a significant relationship was not funded between dividend and
performance proxies and so, signaling theory was not approved. In addition to,
there was a significantly positive relationship between dividend and size. It
indicates that larger firms pay more dividends.
JEL classification numbers: G35, D82
Keywords: Dividend Policy, Signaling Theory, Corporate Operating Characteristics
1
2
3
Faculty of Management, University of Tehran,
e-mail: raei@ut.ac.ir
Faculty of Management, University of Tehran,
e-mail: moradimt@ut.ac.ir.
Faculty of Management, University of Tehran, Iran,
e-mail: heskandar@ut.ac.ir
Article Info: Received : February 20, 2012. Revised : March 29, 2012
Published online : August 31, 2012
14
1
Do dividend policies signal Corporate Operating Characteristics?
Introduction
Dividend policy is one of controversial financial issues. Dividend is an
influential factor in future investment decisions. Dividend policy is quite
important in the valuation process of companies. It decreases internal resources
and increases the need to external resources. In the other hand, many stockholders
prefer pay dividend to retain it. As a result, it is necessary to balance between
investments opportunities and stockholders prefers. Therefore, dividend policies
are sensitive and important [32].
In a pioneering effort, Black [13] finds no convincing explanation of why
companies pay cash dividends to their shareholders. Since that introduction of the
“dividend puzzle,” a voluminous amount of research offers alternative and
appealing approaches to solve it. Most of them are rooted in information
asymmetries between firm insiders and outsiders, and suggest that firms may
indicate their future profitability by paying dividends.
This study examined this question" Do dividend policies signal Corporate
Operating Characteristics?".
Signaling theory is based on the assumption that managers have more
information about the Firm’s future cash flows than do individuals outside the
firm, and they have incentives to signal that information to investors [23]. In the
other words, it suggests that managers use dividends to convey their private
information. Unexpected changes in dividend policy are used to mitigate
information asymmetries between managers and owners [20].
Black [13] found some substantial differences in dividend policy between
developed countries and developing countries, and showed that dividend policies
are different in developed capital markets and emerging capital markets. We
examine signaling theory in Tehran Stock Exchange (TSE). Although, several
studies have examined this theory, our study is different. Firstly, very few studies
examined it in developing countries. We examine Iran, a developing country with
characteristics that are different from those of developed countries and many
emerging economies and developing nations like Malaysia and China [30].
Secondly, several studies examined this theory, but results are different [29].
Therefore, our study appropriately contributes to the literature.
The rest of the paper is organized as follows: Section 2 presents literature
review and hypotheses development. Methodology is discussed in section 3. The
results and conclusions are presented in Section 4 and 5 respectively.
2 Literature Review and Hypotheses Development
Since Miller and Modigliani [33] proposed the dividend irrelevance theorem,
corporation dividend policy has been the focus of economists and produced many
theories of different school. The most prevailing is signal theory [5].
This study examined signaling theory in Iran. Iran is an Islamic country
15
R. Raei, M. Moradi and H. Eskandar
located in the Middle East, a politically troubled and unstable region of the world.
Iran has a unique political and socio economic environment [7].
Tehran Stock Exchange (TSE) is an emerging and somewhat inefficient
capital market [30]. Emerging markets often have less protection for shareholders
and creditors. Therefore, the type and level of conflicts of interest are different
from those in developed markets [16].
Iranian firms have fewer long-term liabilities because of the forbiddance of
bonds [30]. Therefore, corporations are generally financed by issue of common
stocks.
Dividend policy of firms in developing countries significantly differs from
that of the developed countries [1]. There are conflicting evidences about dividend
policy in Iran. Jahankhani and Ghorbani [27] found that dividend policy of Iranian
firms follow random walk. They found that Iranian investors look at dividend as
signal for future performance and cash flow. They showed that firms paying
higher dividends are expected to have more future cash return and better
performance. Samadzadeh [36] examined dividend policy effect on corporate
value and found that dividend policy effect in TSE is unclear. Therefore, the
motive to make dividend announcements to reveal private information is less clear
in Iran. Moreover, he showed that Iranian investors do not look at dividend as a
signal. Mehrani [31] found that there is no pattern for dividend payment in Iran
and firms follow specific and simple dividend policy.
Iranian environmental characteristics make this study interesting.
2.1 Signaling Theory
This theory suggests that there is information asymmetry between managers
and stockholders. Managers have internal information while stockholders have not.
Managers would take costly but credible measures to transfer this information.
One of these measures is dividend. Therefore, dividend policy is a signal to
transfer the information relating to future profitability [4].
Fairchild [19] suggested that firms may reduce dividend and invest remained
cash in profitable projects. But, investors may interpret it (reducing of dividend) as
bad news. Therefore, it is necessary to explain reducing of dividend to investors.
Signaling fans believe that dividend policy is the cheapest of signaling instrument.
Al-Yahyaee et al. [6], Araujo et al. [8] and Frankfurter and Wood [20] obtained
evidence approving this theory. Nonetheless, Bernhardt et al. [12] did not obtained
significant evidence on this theory. Baker et al. [10] found results approving
signaling theory. Seifert [37] examined this theory in America, Canada, France,
Germany, Australia and England, but obtained evidence against to it.
Several surveys identified different factors influencing the payment of
dividends. This study examined signaling theory about operating characteristics.
Operating characteristics include various variables. In this study, they include
three important variables: return, performance and earning.
16
Do dividend policies signal Corporate Operating Characteristics?
Park [34] and Lettaua and Ludvigson [28] found a positive association
between dividend and return. Lie [29] documented evidence on negative market
response to dividend announcements. He suggested that it is because the market
believes reducing of dividend is for earning management and not for investment.
Chen et al. [15] found a weak relationship between dividend and performance.
Harada and Nguyen [24] found significant relationships among dividend,
performance and return. It means that dividend signal performance and return.
Brav et al. [14] found that the link between dividends and earnings has weakened
over time. De Angelo et al. [17] showed that dividend has information content
about earning. Also, Fukuda [21] obtained similar results. However, Baker and
Powell [9] found that the most important factors influencing dividend policy by
corporations listed on the New York Stock Exchange (NYSE) are earning and the
pattern or continuity of past dividends. Baker et al. [11] reported similar results for
NASDAQ firms. Healy and Palepu [25] found that firms that initiate dividends
have positive changes in earnings both before and after the dividend policy change,
they find that firms that omit dividends experience 2 years of significant increase
in earnings.
As a result, we hypothesize that:
H1: There is a significant relationship between dividend and corporate stock
return.
H2: There is a significant relationship between dividend and corporate
performance.
H3: There is a significant relationship between dividend and earning.
2.2 Control Variables
Prior researches identified several factors affect on dividend. For example,
firm size is positively related to dividend policy in [18, 22, 26], and negatively
related in [2]. The leverage of a firm reflects its business risk. Firms with higher
leverage face higher bankruptcy probabilities [3]. Business risk is positively
related in [26] and negatively related in [2, 18, 22]. These control variables
introduced to isolate other contracting incentives that have been found to influence
dividend policy.
3
Methodology
In this study, dependent variable is dividend and independent variables are
return, performance and earning.
17
R. Raei, M. Moradi and H. Eskandar
3.1 Dividend and Return
The following model is used to investigate the relationship between dividend
and return.
Model (1) :
DIVit = α + β1 RETit + β2 SIZEit + β3 LEVit + εit
where
RET : annual retunes for year t.
DIV : the total amount of dividend payouts for year t.
SIZE : natural logarithm of total assets for year t.
LEV : long-term debts to total assets for year t.
ε : error term.
3.2 Dividend and Performance
Defining and measuring performance concept is complex. In this study, Firm
performance is measured by two different variables: Return on Asset (ROA) and
Market to Book Value (MTBV).
The following models are used to investigate the relationship between dividend
and performance.
Model (2):
DIVit = α + β1 ROAit + β2 SIZEit + β3 LEVit + εit
Model (3):
DIVit = α + β1 MTBVit + β2 SIZEit + β3 LEVit + εit
where
ROA : return on assets for year t.
MTBV : market to book value of equity for year t.
Other variables defined as above.
3.3 Dividend and Earning
The following models are used to investigate the relationship between
dividend and earning.
Model (4):
DIVti = α + β1 Eti + β2 SIZEit+ β3 LEVit+ εit
Model (5):
∆DIVti = α + β1 ∆Eti+ β2 SIZEit+ β3 LEVit+ εit
where
E:
net earning for year t.
∆E :
changes in net earning from year t − 1 to year t.
∆DIV : changes in dividend from year t − 1 to year t.
Other variables defined as above.
18
Do dividend policies signal Corporate Operating Characteristics?
3.4 Sample selection
The sample for this study is comprised of all firms listed in TSE excluding
of financial firms. We collected financial and accounting data directly from annual
reports and TSE reports on CDs and web. In this study, sample period is from
2002 to 2008. We select firms, which their fiscal year end is the end of calendar
year, and exclude the firms with insufficient data. Finally, our sample consists of
427 observations.
4
Main Results
4.1 Descriptive statistics
Table 1 describes sample firms’ characteristics in our sample.
Table1: Descriptive statistics
Variable
Min
Max
Mean
S.D
RET
ROA
MTBV
E
E∆
DIV
∆DIV
SIZE
LEV
-4.21
-0.13
-0.20
-95468
-442360
0.00
-5289126
19.94
0.00
5.60
0.54
3.35
6814114
2889601
5320296
2907157
31.59
0.41
0.38
0.18
0.25
184102
35911
141228
1004
25.23
0.08
0.81
0.13
0.24
644299
216458
469329
374646
2.19
0.07
The above table shows that sample firms averagely distributed 77% of their
earnings as dividend (141228/184102). The mean long-term debt is approximately
8% of total assets. This means that Iranian firms have lower long-term liabilities.
It may be interpreted from Iran being an Islamic country and firms have lower
long-term liabilities because of forbiddance of bonds and interest. The mean size
of the sample firms is 25.23 and their market value is about 25% of their book
value. Return of assets is approximately 18%. The mean annual return is 38%.
4.2 Empirical Results
In this section, we represent the results of regression models.
Table 2 shows the results of model (1) (Dividend and Return).
19
R. Raei, M. Moradi and H. Eskandar
Table 2: Results of model (1)
Variable
Coefficient
t-student
P-Value
Constant
-1521548.26
-5.92
0.000
RET
54771.21
1.99
0.047**
SIZE
66422.62
6.50
0.000***
LEV
-455546.84
-1.46
0.145
2
Adj.R : %12
F:19.26
D.W:1.72
***, **, * denote significance at 0.001, 0.05, and 0.10 levels, respectively,
based on t-tests (two-tail).
Durbin-Watson (1.72) indicates that there is no correlation between model
error components.
Adj.R2 shows that 12% of changes in dividends are explained by independent
variables.
Results show that return is positively associated with dividend (coefficient =
54771.21, P-Value = 0.047), supporting the first hypothesis. It means that
dividend has information content about return. This finding is consistent with
Harada and Nguyen [24] and Lettaua and Ludvigson [28].
Moreover, size is positively associated with dividend (coefficient. =
66422.62, P-Value = 0.000). Larger firms are more likely to distribute profits in
the form of dividend. It is in line with Grullon and Michaely [22] and Fama and
French [18].
Table 3 shows the results of model (2) (Dividend and Performance
(measuring by ROA)).
Table 3: Results of model (2)
Variable
Coefficient
t-student
P-Value
Constant
-1613576.24
-6.40
0.000
ROA
151559.63
0.90
0.396
SIZE
69904.39
6.99
0.000***
LEV
-489935.09
-1.56
0.119
Adj.R2: %11
F:18.22
D.W:1.72
***, **, * denote significance at 0.001, 0.05, and 0.10 levels, respectively,
based on t-tests (two-tail).
20
Do dividend policies signal Corporate Operating Characteristics?
Durbin-Watson (1.72) indicates that there is no correlation between model
error components.
Adj.R2 shows that 11% of changes in dividends are explained by independent
variables.
Results show that return on assets is not significantly associated with
dividend, dissupporting the second hypothesis.
Moreover, size is positively associated with dividend (coefficient = 66422.62,
P-Value = 0.000). Larger firms are more likely to distribute profits in the form of
dividend. It is in line with [18, 22].
Table 4 shows the results of model (3) (Dividend and Performance
(measuring by MTBV)).
Table 4: Results of model (3)
Variable
Coefficient
t-student
P-Value
Constant
-1621829.65
-6.41
0.000
MTBV
1597.60
0.47
0.636
SIZE
71115.57
7.17
0.000***
LEV
-532161.59
-1.72
0.087*
Adj.R2: %11
F:18.00
D.W:1.73
***, **, * denote significance at 0.001, 0.05, and 0.10 levels, respectively,
based on t-tests (two-tail).
Durbin-Watson (1.73) indicates that there is no correlation between model
error components.
Adj.R2 shows that 11% of changes in dividends are explained by independent
variables.
Results show that MTBV is not significantly associated with dividend,
dissupporting the first hypothesis. It means that dividend payouts do not show
sensitivity to MTBV.
Nonetheless, size is positively associated with dividend (coefficient. =
66422.62, P-Value = 0.000). Larger firms are more likely to distribute profits in
the form of dividend. It is in line with [18, 22]. Moreover, LEV is negatively
associated with dividend (coefficient. = -532161.59, P-Value = 0.087). It means
that firms with higher LEV pay fewer dividends. It is in line with [18, 22].
Table 5 shows the results of model (4) (Dividend and Earning).
21
R. Raei, M. Moradi and H. Eskandar
Table 5: Results of model (4)
Variable
Coefficient
t-student
P-Value
Constant
-507885.36
-4.45
0.000
E
0.64
41.83
0.000***
SIZE
21376.25
4.72
0.000***
LEV
-111598.13
-0.82
0.415
2
Adj.R : %83
F:675.96
D.W:1.84
***, **, * denote significance at 0.001, 0.05, and 0.10 levels, respectively,
based on t-tests (two-tail).
Durbin-Watson (1.84) indicates that there is no correlation between model
error components.
Adj.R2 shows that 83% of changes in dividends are explained by independent
variables.
Results show that earning is positively associated with dividend (coefficient.
= 0.64, P-Value = 0.000), supporting the third hypothesis. It means that more
profitable firms pay more dividends. It is consistent with [17].
Moreover, size is positively associated with dividend (coefficient. =
21376.25, P-Value = 0.000). Larger firms are more likely to distribute profits in
the form of dividend. It is in line with [18, 22].
Table 6 shows the results of model (5) (changes in Dividend and changes in
Earning).
Table 6: Results of model (5)
Variable
Coefficient
t-student
P-Value
Constant
-212929.42
-1.06
0.290
∆E
0.65
8.09
0.000***
SIZE
7717.11
0.97
0.332
LEV
-78522.56
-0.33
0.743
Adj.R2: %15
F:25.56
D.W:1.94
***, **, * denote significance at 0.001, 0.05, and 0.10 levels, respectively,
based on t-tests (two-tail).
22
Do dividend policies signal Corporate Operating Characteristics?
Durbin-Watson (1.94) indicates that there is no correlation between model
error components.
Adj.R2 shows that 15% of changes in dividends are explained by independent
variables.
Results show that changes in earning is positively associated with changes in
dividend (coefficient. = 0.65, P-Value = 0.000), supporting the third hypothesis. It
means that changes in dividends depend on changes in earnings. It is consistent
with [17].
5
Conclusion
Dividend policy is one of controversial financial issues. There are various
theories about dividend but in this study, the focus is on empirical test of signaling
theory. Signaling theory is based on the assumption that managers have more
information about the Firm’s future conditions than do individuals outside the firm,
and they have incentives to signal that information to investors. In the other words,
dividend has information content and conveys important financial information.
This study examined signaling theory about operating characteristics.
Operating characteristics include various variables. In this study, they include
three important variables: return, performance and earning. Regressions models
were fitted.
Results showed that significantly positive correlation exists between
dividend and return. Also, there was a similar relationship between dividend and
earning. It means that dividend has information content about return and earning
and so, signaling theory was approved about them. Nonetheless, a significant
relationship was not funded between dividend and performance proxies and so,
signaling theory was not approved. In addition to, there was a significantly
positive relationship between dividend and size. It indicates that larger firms pay
more dividends.
References
[1] Cahit Adaoglu, Instability in the dividend policy of the Istanbul Stock
Exchange ISE/corporations: evidence from an emerging market, Emerging
Market Review, 1, (2000), 252-270.
[2] V. Aivazian, I. Booth and S. Cleary, Do Emerging Market Firms Follow
Different Dividend Policies From U.S. Firms?, Journal of Finance Research,
26(3), (2003), 371-387.
[3] R. Aggarwal and N.A. Kyaw, Capital structure, dividend policy, and
multinationality: Theory versus empirical evidence, International Review
Finance Analysis, 10, (2010), 1-11.
23
R. Raei, M. Moradi and H. Eskandar
[4] J. Aharony and I. Swary, Quarterly Dividend and Earnings Announcements
and Stockholders' Returns: An Empirical Analysis, Journal of Finance, 7,
(1980), 15-25.
[5] F.R. Allen and R. Michaely, Payout Policy, 1/E, Handbook of the economics
of Finance, 2003.
[6] K.H. Al-Yahyaee, T.M. Pham and T.S. Walter, The information content of
cash dividend announcements in a unique environment, Journal of Banking
and Finance, 10, (2010), 1-7.
[7] M. Arabsalehi and M.A. Velashani, Financial reporting gap in developing
countries: the case study of Iran, Middle Eastern Finance and Economic, 3,
(2009), 77-88.
[8] A. Araujo, H. Moreira and M. Tsuchida, Do dividend changes signal future
earnings?, Journal of Finance Intermediate, 4, (2010), 1-18.
[9] H.K. Baker and G.E. Powell, Determinants of corporate dividend policy: a
survey of NYSE firms, Finance Practical Education, 10(1), (2000), 29-40.
[10] H.K. Baker, S. Saadi, S.H. Dutta and D. Gandhi, The perception of
dividends by Canadian managers: new survey evidence, International
Journal of Managerial Finance, 3(1), (2007), 70-91
[11] H.K. Baker, E.T. Veit and G.E. Powell, Factors influencing dividend policy
decisions of Nasdaq firms, Finance Review, 36(3), (2001), 19-37.
[12] D. Bernhardt, A. Douglas and F. Robertson, Testing dividend signaling
models. Journal of Empirical Finance, 12, (2005), 77-98.
[13] F. Black, The dividend puzzle, Journal of Portfolio Management, 2, (1976),
5-8.
[14] A. Brav, J.R. Graham, C.R. Harvey and R. Michaely, Payout policy in the 21
st century, Journal of Finance & Economic, 77(3), (2005), 483-527.
[15] Z. Chen, Y. Cheung, A. Stouraitis and A. Wong, Ownership concentration,
firm performance, and dividend policy in Hong Kong, Pacific-Basin Finance
Journal, 13, (2005), 431-449.
[16] S. Claessens, S. Djankov and L.H.P. Lang, The separation of ownership and
control in East Asian corporations, Journal of Finance and Economic,
58(1-2), (2000), 81-112.
[17] H. DeAngelo, L. DeAngelo and D. Skinner, Special dividends and the
evolution of dividend signaling, Journal of Finance and Economic, 57,
(2000), 309-354.
[18] E. Fama and K. French, Disappearing dividends: changing firm
characteristics or lower propensity to pay, Journal of Finance and Economic,
60, (2001), 3-43.
[19] R. Fairchild, Dividend Policy, Signaling and Free Cash flow: An Integrated
Approach, Working Paper, Emerald, (2010).
[20] G. Frankfurter and B. Wood, Dividend policy theories and their empirical
tests, International Review of Finance Analysis, 11, (2002), 111-138.
[21] A. Fukuda, Dividend changes and earnings performance in Japan,
Pacific-Basin Finance Journal, 8, (2000), 53-66.
24
Do dividend policies signal Corporate Operating Characteristics?
[22] G. Grullon and R. Michaely, Dividends, share repurchase and the substitution
hypothesis, Journal of Finance, 57(4), (2002), 1649-1684.
[23] K. Gugler, Corporate governance, dividend payout policy and the
interrelation between dividends, R&D, and capital investment, Journal of
Banking and Finance, 27(7), (2003), 1297-321.
[24] K. Harada and P. Nguyen, Dividend change context and signaling efficiency
in Japan, Pacific-Basin Finance Journal, 13, (2005), 504-522.
[25] P. Healy and K. Palepu, Earnings information conveyed by dividend
initiations and omissions, Journal of Finance and Economic, 21, (1988),
149-175.
[26] H. Ho, Dividend Policies in Australia and Japan, International Advance
Economic Research, 9(2), (2003), 91-100.
[27] A. Jahankhani and S. Ghorbani, Recognition of determinants factors of
dividend policy among the firms accepted in Tehran stock exchange, Finance
Research, Iran, 20, (2006), 27-48.
[28] M. Lettaua and S. Ludvigson, Expected returns and expected dividend
growth, Journal of Finance & Economic, 76, (2005), 583-626.
[29] E. Lie, Operating performance following dividend decrease and omissions,
Journal of Corporate Finance, 12, (2005), 27- 53.
[30] B. Mashayekhi and S.H. Mashayekh, Development of accounting in Iran, The
International Journal of Accounting, 43, (2008), 66-86.
[31] S. Mehrani, The model for the relation between earnings, dividend and
investment, M.S. thesis, The University of Tehran, Iran, 1995.
[32] S. Mehrani and A.R. Talaneh, Dividend in firms, Accountant Journal, Iran,
125, (1998), 10-15.
[33] M. Miller and F. Modigliani, Dividend Policy, growth and valuation of
shares, Journal of Busin, 2, (1961), 411-433.
[34] C.H. Park, When does the dividend–price ratio predict stock returns?,
Journal of Empirical Finance, 17, (2010), 81-101.
[35] R. Sant and A. Cowan, Do dividends signal earnings? omitted dividends.
Journal of Banking and Finance, 18, (1994), 1113-1133.
[36] Mohsen Samadzadeh, Dividend policies and their effects on corporate value
in Tehran stock exchange, M.S. thesis, The University of Esfahan, Iran, 1994.
[37] B. Seifert, Earnings and dividend changes: An international study, Journal of
Multinational Financial Management, 7, (1997), 71-81.